Additionally, we believe the regulatory environment is likely to improve at least somewhat with the new congressional mix in Washington, which could help open up more drilling and take some of the more damaging environmental proposals off the table.
To be sure, near-term sentiment may shift quickly due to any number of factors, and we suggest using pullbacks to add to positions as needed.
From a fundamental perspective, several countries are putting austerity measures (spending cuts) into place, which could dampen economic growth, while China, as mentioned above, recently increased interest rates and boosted bank reserve requirements. While this is modestly concerning, the market has responded relatively well and we believe there will be minimal near-term impact on energy demand as a result of these moves.
Longer term, we maintain a positive outlook for the energy sector. Developing countries will almost certainly continue to demand more fuel and, once economies around the world start to show sustainable growth, we believe that will solidify demand.
Positive factors for the energy sector:
- Global uncertainties could threaten some supplies, exacerbating an already-worrying situation.
- Developing nations will likely need more energy as they improve their infrastructures and modernize their economies.
- The Institute for Supply Management (ISM) manufacturing index remains in territory depicting strong expansion, which could bode well for the economically sensitive energy group.
- Purchasing manager index (PMI) surveys around the globe have been largely better than expected—potentially boding well for manufacturing and energy demand.
Negative factors for the energy sector:
- Supplies could increase dramatically with a renewed commitment to exploration and technological improvements. Should oil companies step up efforts to access those supplies, oil prices could fall.
- Some international governments are starting to rein in their stimulative policies, threatening to slow the rate of growth in the global economy.
- Inflation concerns are starting to heat up globally. Central banks could tighten as a consequence, resulting in the possibility of economic slowing.
Financials have cooled a bit lately following an earnings season that reminded investors of the many challenges still facing much of the group. Investors who'd been aggressively value hunting in financials may have recognized that there were some valid reasons for the lower prices. We remain cautious and believe this is the start of at least a near-term trend, and are maintaining our underperform view on the sector.
New regulations limit trading that financial institutions can do for themselves, which has been a major profit driver for some companies. And new capital requirements restrict the amount of money banks can lend, limiting profit potential for many of them.
This continues a trend of governments around the world imposing new taxes, fees and regulations on the financial industry, which we believe will weigh down the group.
Additionally, although the mortgage market continues to stabilize, it remains a long climb back to some sense of normalcy. Housing remains a risk as foreclosures mount, saddling banks' balance sheets with unwanted assets that will likely have to be marked down.
Adding additional consternation was the recent moratorium put in place for future foreclosures due to uncertainty regarding paperwork. While that issue appears to have just been a blip, it still has the potential to flare up again as we move forward, as seen by a recent court decision invalidating the foreclosure of a couple of homes due to documentation issues.
Although we maintain confidence in the ability of the financial industry to reshape itself and adjust to the changing environment as it has done so many times in the past, we believe it will take some time and that the current headwinds will likely continue for the time being.
Positive factors for the financials sector:
- More financial institutions are paying back government loans, illustrating their growing health and stability.
- Capital market activity has been increasing, which should help boost revenues in the investment banking arena.
- Recent delinquent loan estimates have decreased among credit card companies, indicating improving balance sheets.
- Lending standards have loosened somewhat, which could help loan volume grow.
- Credit card delinquencies have fallen sharply.
Negative factors for the financials sector:
- Revolving home equity loans are declining, typically a bad sign for bank profits and stock performance.
- New regulations have severely restricted the ability of lenders to offer "exotic" mortgages, cutting back on the volume of business they can do.
- New credit card rules have gone into effect, which could hurt profitability going forward.
- Confidence in the financials sector, though improved, remains shaky. Concerns about the still-fragile housing market—combined with increased government regulation—continue to hover over the group.
- Uncertainty as to how massive government intervention will affect the financial industry going forward could hold back performance for the foreseeable future.
- A new round of foreclosure uncertainty could pose problems for the financial sector.
We were tired of swimming upstream and recently moved our view of health care from outperform to marketperform. Although we believe the fundamental picture of the group is still quite attractive, investor interest remains virtually nonexistent.
